NEW YORK (CNNMoney.com) -- Stocks slumped and bonds rallied Tuesday after the Federal Reserve cut the fed funds rate by a quarter-percentage point, as expected, but disappointed some investors looking for a bigger cut.

The Dow Jones industrial average (Charts) lost over 294 points, or 2.1 percent, according to early tallies. The broader S&P 500 (Charts) index lost 2.5 percent. The tech-fueled Nasdaq (Charts) composite lost almost 2.5 percent.

Stocks had posted modest gains ahead of the decision, but quickly turned lower following the afternoon decision and statement. Treasury market gains accelerated rapidly after the decision, lowering the corresponding yields.

"The stock market was looking for a bigger cut and so there's some disappointment," said Georges Yared, chief investment strategist at Yared Investment Research.

The selling was also influenced by the recent rally on Wall Street, which had left the Dow and S&P 500 within reach of the record highs hit in October.

"The market has gone up in recent weeks on expectations that the Fed would cut, so you're seeing a 'buy the rumor, sell the news' reaction," said Alan Skrainka, chief market strategist at Edward Jones.

The central bank voted to cut the fed funds rate by a quarter-percentage point to 4.25 percent. The fed funds rate is a key short-term lending rate that influences consumer loans. The central bank has cut it three times since September, in an attempt to loosen up tight credit markets and protect the economy from falling into a recession amid the fallout in the housing market.

Many Wall Streeters had been looking for the Fed to cut rates by a quarter-percentage point, or 25 basis points, particularly after last week's upbeat November jobs report cooled some fears about the slowing economy. But some on Wall Street had been looking for a bigger cut of a half-percentage point, or 50 basis points. There are 100 basis points in one percentage point.

The Fed also cut the discount rate, which influences bank loans, by 25 basis points, versus broader expectations for a 50-basis point cut.

In the accompanying statement, the bankers changed the language to suggest the economic slowdown was more pronounced than it had been at the time of the last meeting at the end of October.

"Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending," the bankers wrote.

"Clearly the stock market did not like that they [the bankers] sort of talked down the economy and then only gave them a quarter-point cut," said Joshua Shapiro, chief economist at Maria Fiorini Ramirez Inc. He said that the bond market was also reacting to the perception of a more negative economic outlook.

Treasury prices built on gains from before the statement was released, lowering the yield on the 10-year note to 4.03 percent from 4.15 percent late Monday. Treasury prices and yields move in opposite directions.

One notable standout on the Dow was AT&T (Charts, Fortune 500), which said it is boosting its quarterly dividend and that it will buy back 400 million shares of its stock. The stock jumped over 5.5 percent.

Washington Mutual (Charts, Fortune 500) said late Monday that it was cutting both its dividend and more than 3,000 jobs in the wake of the housing and credit market crisis. Citi Investment Research downgraded the stock to "sell" from "hold."

Freddie Mac (Charts, Fortune 500)'s chief executive said Tuesday that the company will probably lose another $5.5 billion to $7.5 billion over the next few years amid the ongoing housing market fallout.

Market breadth was negative. On the New York Stock Exchange, losers beat winners by five to one on volume of 1.09 billion shares. On the Nasdaq, decliners topped advancers by three to one on volume of 1.71 billion shares.